Paul Graham: ‘Money Is Not Wealth’. Really?

September 27, 2012 3:19 pm

Paul Graham writes very convincingly. So when he makes an argument saying Money is not Wealth and backs it up with strong points on how money is just a medium to move wealth but it is only wealth that can be created, it is very difficult to spot fallacies of any kind in the argument. But we spotted a weak signal of Narrative Fallacy in the argument.

While his argument on how it is wealth that needs to get created is spot on, he goes a little too far with the assumption that Money is just a medium. It used to be, in the old days when there was a more or less “fixed” amount of money. But in today’s world of operation twists and QEs, looking at Money as just a medium to move wealth around, would be a mistake. Why do we say that?

Not because Bernanke can print Money. But because, the premise of Paul Graham’s argument, which is that you need to create wealth – something people want, makes this critical assumption:

“The advantage of a medium of exchange is that it makes trade work. The disadvantage is that it tends to obscure what trade really means. People think that what a business does is make money. But money is just the intermediate stage– just a shorthand– for whatever people want. What most businesses really do is make wealth. They do something people want.”

The issue though, is that the medium is heavily manipulated these days. In a scenario where governments and central banks can essentially create money, just because they can, looking at Money as just an intermediate stage would be a serious mistake. It is very much part of the equation (unless attempts like Bitcoin change the concept of Money) – a central bank issuing currency based on an asset takes a totally different meaning when that asset is just trust.

Startups need to understand that the concept of creating Money is changing, and hence need to err on the conservative side, when the wealth they create, gets translated into Money. One example is valuation. Remember this is more or less free “money” (low interest rates) – the economy is bad but who cares – the cost of capital is unbelievably low, you shd count that in when you raise money, for example.

Is it not strange, that investors conveniently refer to a ‘bad economy’ and never refer to a zero percent interest rate scenario, which shd be the more relevant question – the cost of money?

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1 Comment for “Paul Graham: ‘Money Is Not Wealth’. Really?”

In fact there has never been a relatively “fixed” amount of money. What was previously fixed was the correlation between money and value.

It is self-evident that the world doesn’t spontaneously create new value through artificial means — new value is only created through natural processes (e.g. birth, organic growth, the assembly of raw minerals into items of utility, in other words a localized reduction in entropy in the universe).

What isn’t self-evident is what happens when money is no longer anchored to the aggregate limited inorganic value (minerals and raw materials extracted from nature and converted to utility value) and the limited organic value (the living organisms that exist in the world, the order that has temporarily formed out of chaos despite entropy) that was formerly the basis of the economy and which is supposed to be the basis of the value of money in a reasonable and equitable civilization.

When money is “de-based” it loses this anchor to natural value, and either a deflationary spiral or a hyperinflationary shock may result. Most people who study these dynamics assert that one or the other MUST result.

It is very important to understand that increasing money supply (M1, M2, M3, etc) does not itself de-base a currency. When money supply increases without the velocity of money increasing, when money is still unavailable to those who hold the value in the economy and when this increase in money supply (capital) is systematically mis-allocated to activities that do not produce wealth or create growth, deflation is the result rather than inflation. It may also result in the economy shifting away from use of the deflating currency as a method of exchange or a means of expression for participants in the economy and instead treating it as a store of value attractive to non-participants. See: Deflation, Japan

When money becomes the perceived store of value instead of the method of exchange there is a disincentive to spend it and those who can acquire it through artificial means prefer to hold it, and to acquire future rights to receive more of it at irrational prices. See: US Treasury Bubble

What people who fear QE3 and Operation Twist and other “inflationist” policies are concerned about is a loss of purchasing power that would result if everyone ends up with more money because of these policies. But there are two scenarios that are far more likely at this point in the macroeconomic cycle: further concentration of capital into the hands of the powerful and already-wealthy, or, just as uncomfortable for most people: governments attempting to prop up broken, intrinsically-insolvent and structurally-flawed systems of money recycling that purport to be “production” but which consume value instead of producing it and do so on such a large scale that nobody knows whether the value they hold today will be negotiable value tomorrow.

In the latter scenario the governments that kick the can down the road and try to avoid allowing the market to recognize the structural collapse that has already happened tends, historically, to result in one thing: the eventual structural collapse of these prop-up governments with their managed political economies.

If we don’t get inflation under the present US policies then we get to choose between an oligarchy or a revolution as the end-game.

Straight inflation would solve many of the present problems. But inflation means everyone has more money, and that clearly is not what’s happening.

Every transaction that we engage in that doesn’t contribute to the core inflation rate in some way (knock-on effects included) transfers value into our money instead of transferring it to each other and producing new growth. This is the deflationary spiral of a rapidly- and persistently-rising perceived value of money, and it happens when nobody has enough of it to meet their needs and satisfy their wants, so everybody hoards and conserves it out of fear.